If you received a Franchise Disclosure Document (FDD) that includes a Financial Performance Representation (FPR), you should review the FPR and the franchisor’s disclaimers in detail. While FPRs are subject to strict disclosure rules, franchisors have significant leeway in what they choose to disclose, and they often use broad disclaimers to minimize their liability exposure. You should have the FPR (and the entire FDD) reviewed by an experienced franchise lawyer as well.
The FTC’s Franchise Rule gives franchisors the option to include a Financial Performance Representation (FPR) in Item 19 of the Franchise Disclosure Document (FDD). As the FTC explains, if a franchisor chooses to include an FPR in Item 19, the franchisor “must . . . have a reasonable basis and written substantiation for the representation at the time it is made, and disclose the bases and assumptions underlying the representation.”
The FTC also advises franchisors to “keep in mind not only the affirmative disclosure requirements in Item 19, but the parallel prohibitions against making representations that are not true or are not substantiated at the time they are made.” In other words, Item 19 FPRs are subject to strict requirements—and this is why many franchisors simply choose not to provide them. So, if you received an FDD that includes an FPR, what do you need to know? Here are some key insights from national franchise lawyer Jeffrey M. Goldstein:
What Should You Look for in an Item 19 FPR?
When reviewing a franchisor’s Item 19 FPR, a key first step is to assess what exactly the franchisor is representing. Some examples of questions you will want to answer include:
- What are the franchisor’s numbers based on? Are they based on data from franchisees or company-owned outlets? Or are they projections?
- Do any revenue figures presented represent gross sales or net profit?
- When calculating costs, what specific costs is (and isn’t) the franchisor taking into account?
- Is the franchisor using averages, medians, or ranges? If so, how exactly are these calculated?
- Is the franchisor excluding any key factors, such as royalty fees or underperforming outlets?
Again, this is just a handful of examples. Financial Performance Representations range widely in complexity and clarity, so it is important to start by making sure you know what information is (and isn’t) being provided. Once you know what you’re looking at, then you can assess what it means (if anything) for your franchise opportunity.
Along with examining the FPR itself, you should also examine the franchisor’s disclaimers. As mentioned above, franchisors routinely include extensive disclaimers with their FPRs. While this is typically done to prevent prospective franchisees from claiming reliance on the numbers presented, franchisors often include more substantive disclaimers as well. For example, disclaimers may state that the FPR relies on assumptions that don’t apply to your geographic location, or that it’s based on only a small subset of the system’s total outlets.
What Are Some Red Flags in Item 19 FPRs?
Item 19 FPRs can contain a variety of red flags. As a prospective franchisee, knowing how to spot these red flags will help you make an informed buying decision. While the following issues are not necessarily indicative of fraud, bad faith, carelessness, or other concerns, they will usually signify that further investigation is warranted:
- Inconsistencies between Item 19 and a franchisor’s other disclosure materials
- Inconsistent financial disclosures within a franchisor’s Item 19 FPR
- Significant gaps in a franchisor’s financial disclosures (i.e., omitting particular groups of franchisees)
- Financial performance claims that lack substantiation
- Reliance on financial projections when a franchisor has historical financial data available
These are just examples. If you hire an experienced franchise lawyer to advise you during the buying process, your lawyer can explain everything you need to know to decide what to take away from a franchisor’s Item 19 FPR.
FAQs: Evaluating Franchisors’ Item 19 Disclosures as a Prospective Franchisee
Why don’t some franchisors provide a Financial Performance Representation (FPR) in Item 19?
Since providing a Financial Performance Representation (FPR) in Item 19 isn’t mandatory, some franchisors simply choose not to provide them. Preparing a compliant Item 19 FPR takes time, and franchisors can face liability if they publish inaccurate or misleading FPRs in their Franchise Disclosure Documents (FDDs).
What if a franchisor doesn’t provide a Financial Performance Representation (FPR) in Item 19?
If a franchisor chooses not to provide a Financial Performance Representation (FPR) in Item 19, this is not necessarily a positive or a negative from a prospective franchisee’s point of view. As a prospective franchisee, feel free to ask why a franchisor has opted not to provide an FPR, and consider the franchisor’s answer when evaluating the franchise opportunity.
How much can (and should) I rely on a franchisor’s Item 19 disclosures?
As a prospective franchisee, you must conduct your own financial analysis. As a result, while a franchisor’s Item 19 disclosures can be informative, you should not use them as a substitute for doing your own due diligence. Ultimately, you must make an informed buying decision.
What We Can Do to Help
If you are thinking about buying a franchise, we can help you make an informed buying decision. We have decades of experience advising prospective franchisees, and we routinely review FDDs and franchise agreements for both first-time and experienced franchise buyers. We offer several flat-fee franchise business review programs, and we can help you choose the program that best fits your circumstances.
Schedule a Free Consultation with National Franchise Lawyer Jeffrey M. Goldstein
To learn more about our flat-fee franchise business review programs for prospective franchisees, contact us today. Call 202-293-3947 or tell us how we can reach you online to start a free consultation.
